Monday, March 24, 2008

Equity futures are up pre-market on news that JP Morgan may revise its bid higher for Bear Stearns. Looks like we will see some follow through last weeks short covering bounce…

Bear Stearns Rises on Report of Higher JPMorgan Bid (Update3): “Bear Stearns Cos. surged more than 50 percent in early trading in New York after the New York Times reported that JPMorgan Chase & Co. may quintuple its takeover offer for Bear Stearns Cos. to more than $1 billion in an effort to win support from employees and shareholders opposed to the deal.”

I can see this making sense. JP doesn’t want to take on 7000 pissed off employees that have been bankrupted. (1/3 of Bear Stearns was owned by its employees.) Raising the prices may sooth some frayed nerves and prevent a long drawn out legal battle.

Clearly Joesph Lewis has been furiously manning the phones in a last ditch effort to make some of his billion back.

“Lewis and James “Jimmy” Cayne, Bear Stearns's 74-year-old former chief executive officer, are trying to recruit investors to counter JPMorgan's offer, the New York Post reported last week, citing people familiar with the situation.”

Since nobody else can match the Fed backstop of $30 billion and since JP gets the prized most prized procession either way (the Bear Stearns headquarter building), I don’t actually take these attempts seriously.

The New York-based company drew on its entire $7.3 billion of emergency credit lines last week after ratings downgrades left it unable to finance itself with commercial paper. The company may also raise $5 billion to $7 billion through asset sales.

CIT will probably have to sell itself to another lender to survive, as its business model, which relies on its ability to raise short-term debt backed by its loans, has been made obsolete by the drying-up of credit markets, the Journal added, citing unidentified people.”

Goldman, Lehman Rating Outlook Cut to Negative by S&P (Update3): “Goldman Sachs Group Inc., the biggest U.S. securities firm, and smaller rival Lehman Brothers Holdings Inc. had their credit-rating outlook cut to negative by Standard & Poor's, which said Wall Street banks' profits may fall as much as 30 percent in the coming year.”

This isn’t getting nearly as much play as it should in the media. People will forget probably forget about it until actual day that Goldman or Lehman get downgraded comes… and the market will freak out and act ‘surprised’.

I would let Lehman Brothers and Goldman Sachs bounce some more and then look for a nice, low risk short entry. To reduce the carnage of a sudden, giant up gap up in the morning on some ridiculous news, puts are an option.

Even after cutting rates by 3 percentage points since September, expanding the range of securities it accepts as collateral for loans and giving dealers access to its discount window, the Fed has been unable to promote confidence. The difference between what the government and banks pay for three- month loans doubled in the past month to 1.92 percentage points.

The only tool left may be for the Fed to help facilitate a Resolution Trust Corp.-type agency that would buy bonds backed by home loans, said Bill Gross, manager of the world's biggest bond fund at Pacific Investment Management Co. While purchasing some of the $6 trillion mortgage securities outstanding would take problem debt off the balance sheets of banks and alleviate the cause of the credit crunch, it would put taxpayers at risk.”

These rumors have be circulating for weeks now but have started to become more widely accepted. This has helped put a giant short covering bid into Fannie Mae and Freddie Mac. Both have rallied almost 100% off their recent lows.

Regulators have approved $200 billion in ADDITIONAL purchasing power. How exactly? Well simple of course. Fannie and Freddie have had their regulatory capital surplus requirements REDUCED from 30% to 20%. In other words: THEIR ALLOWABLE LEVERAGE HAS BEEN INCREASED. Considering that both companies are really massively leveraged already, I fail to see how this is Bullish for anything. In actual fact, this should SCARE THE SHIT out of rational people. Basically mortgage risk, which is already highly concentrated in these two players, is being further concentrated in these two players.

As for the rally in FNM and FRE, it is also due in part to the 'implicit' guarantee being made a bit more explicit via the relaxation of the capital requirement. Combined with the talk out of Washington, e.g about measures to stem foreclosure, I think people have taken this as a giant hint that the guarantee is more explicit than implicit.

I agree about the implicit guarantee being made more explicit recently... but that does not mean COMMON SHAREHOLDERS will get anything. Much like the ORIGINAL Bear Stearns deal, FNM and FRE shareholders will most likely get tossed under the bus.

Disclaimer

The Financial Ninja is a collection of my thoughts and opinions about current economic and market conditions. These are not buy and sell recommendations. Use your head and do your own research. This is a forum to stimulate discussion and debate.

About Me

I started trading during the tech bubble when I was still in high school. My trading has financed my education and I have since completed a BA in Economics and an MBA with a concentration in Finance. I have worked as both a proprietary equity and fixed income derivatives trader.